Politics of investing
Elections — and their results — make investment portfolios volatile. On May 3, the Sensex was 38963. Only 10 days later, it had slid to 37090. As the exit polls signalled the return of the incumbent, the 30-stock index jumped over 1400 points in a single day.
On Thursday, as the trends signalled a decisive victory for Prime Minister Modi, the Sensex breached 40,000 for the first time ever. It hit an intra-day high of 40124 before plunging 1300 points on account of profit booking to finish the day at 38811.
The stock markets recede during political uncertainty but are also buoyed by decisive mandates and signs of political stability. However, for new investors, all this excitement may be a lot to bear. What’s the best way to deal with the volatility and uncertainty brought about by the country’s politics?
What’s your goal?
For starters, the guiding light for any investment must be a clearly-defined goal. To set an investment goal, you must answer several questions. How much do you need to invest? For how long? What must be the expected rate of return? How liquid is the investment? How much tax must you pay on your returns?
For example, your investment goal is to save Rs 3.5 crore in 30 years at an expected rate of return of 12 per cent per annum, so you work backwards and calculate that you need to invest Rs 10,000 per month for 30 years to reach your goal. Now, during this 30-year period, there will be countless market corrections and more than a few crashes. This is part of the deal. You must see where you are with respect to achieving your goal and decide whether to remain invested or cash out.
Take stock of progress
Equity investment is a long-term game. The longer you hold on to your investments, the greater possibility there will be for compounded growth which helps you accelerate towards your goals.
During any period of volatility, your first reaction shouldn’t be to sell and run. Take stock of your investment progress periodically — at least once a month. If you have achieved your goal, or are very close to achieving it, a phase of volatility will harm your pay-out.
Even a period such as now where the market reacts positively to a decisive mandate, there may be the temptation to hold your units to increase your profits. But this, too, is a risky proposition.
Once your goal is met, book your profits and cash out. But if you’re far from your goal with lots of time left in your tenure, a market correction or a crash offers the great chances to reduce your average purchase costs and buy stocks or mutual fund units at lower prices. Lumpsum purchases during these periods will help you accelerate towards your goal in the long term.
Know your risks
Equity investment carries market risks. Debt investment carries interest rate and credit risks. One must know these risks and how they impede wealth creation.
With equity investment especially, one must understand one’s risk appetite in order to cope with the losses that may happen periodically.
Risks should also be calibrated in line with the investment tenure. For example, long-term investors can afford to take higher risks for this offers long periods of time to recover from losses and may lead to significantly higher returns compared with debt instruments. But short-term investors will be playing with fire by taking market risks since there is less time to recover.
Rebalancing your portfolio
Your portfolio must be balanced according to your risk appetite. If your portfolio is exposed heavily to certain kinds of risks, you must rebalance it to reduce those risks. For example, you could consider building an equity portfolio with high-quality blue-chip investments instead of high-risk small caps.
And if you have invested heavily in small-caps, you should consider increasing the proportion of large-caps in your portfolio to counteract against your risks. Even in the same asset class, you could meaningfully reduce risks. For example, instead of direct equity exposure to a handful of stocks, you could opt for a well-hedged portfolio of many stocks in the form of a diversified mutual fund.
As the adage goes, don’t put all your eggs in one basket. Along with your high-returns long-term investments, take care of your liquidity needs and make contributions towards investments that provide assured returns.
Meet your liquidity needs with fixed deposits or liquid mutual funds. Manage your mid-term needs with options such as PPF or balanced mutual funds. A good mix of investments in the right proportion will help you meet your goals, reduce tax on investments, earn optimum returns and help you meet your financial goals in a timely manner.
The writer is CEO of `BankBazaar.com`